Chapter 13, Problem 55P

1.

To determine

Prepare quality cost report and pie chart.

Explanation of Solution

Quality Cost:

Organizations are required to bear costs due to non-conformity of goods or services with the general specifications. These costs are termed as quality costs. Quality costs can be categorized into preventive costs, detective costs, internal failure costs and external failure costs.

Preparation of quality cost report:

Particulars	Year 1 ($)	Year 2 ($)
Prevention costs:
Quality circles	6,000	60,000
Design reviews	3,000	30,000
Quality improvement projects	3,000	150,000
Total prevention costs (A)	12,000	240,000
Percentage (E)	0.39%	7.81%
Detection costs:
Packaging inspection	480,000	450,000
Product acceptance	60,000	42,000
Total detection costs (B)	540,000	492,000
Percentage (F)	17.58%	16.02%
Internal failure costs:
Scrap	420,000	360,000
Rework	540,000	480,000
Yield losses	240,000	150,000
Retesting	300,000	240,000
Total internal failure costs (C)	1,500,000	1,230,000
Percentage (G)	48.83%	40.04%
External failure costs:
Returned materials	240,000	240,000
Allowances	180,000	210,000
Warranty	600,000	660,000
Total external failure costs (D)	1,020,000	1,110,000
Percentage (H)	33.20%	36.13%
Total quality costs $\left(\text{A}+\text{B}+\text{C}+\text{D}\right)$	3,072,000	3,072,000
Total percentage $\left(\text{E}+\text{F}+\text{G}+\text{H}\right)$	100%	100%

Table (1)

Pie chart for year 1:

Fig (1)

Pie chart for year 2:

Fig (2)

Analysis of pie charts:

• The distribution pattern shown in the chart in year 1 is not appropriate.
• External failure costs and internal failure costs are much higher than their required levels.
• In comparison with year 1, year 2 is moving towards a right balance; since failure costs are reducing and prevention costs are increasing.

2.

To determine

Present a performance report for year 2 by comparing budgeted and actual figures of year 2. Also, compute the profits that have been increased due to quality improvements.

Answer to Problem 55P

Increase in profit due to quality improvements is $768,000.

Explanation of Solution

Preparation of quality cost report:

Particulars	Year 1 ($)	Year 2 Budgeted ($) (E)	Year 2 Actual ($) (F)	Variance ($) $\left(\text{E}-\text{F}\right)$
Prevention costs:
Quality circles	6,000	7,500	60,000	$\left(52,500\right)$
Design reviews	3,000	3,750	30,000	$\left(26,250\right)$
Quality improvement projects	3,000	3,750	150,000	$\left(146,250\right)$
Total prevention costs (A)	12,000	15,000	240,000	$\left(225,000\right)$
Detection costs:
Packaging inspection	480,000	600,000	450,000	150,000
Product acceptance	60,000	75,000	42,000	33,000
Total detection costs (B)	540,000	675,000	492,000	183,000
Internal failure costs:
Scrap	420,000	525,000	360,000	165,000
Rework	540,000	675,000	480,000	195,000
Yield losses	240,000	300,000	150,000	150,000
Retesting	300,000	375,000	240,000	135,000
Total internal failure costs (C)	1,500,000	1,875,000	1,230,000	645,000
External failure costs:
Returned materials	240,000	300,000	240,000	60,000
Allowances	180,000	225,000	210,000	15,000
Warranty	600,000	750,000	660,000	90,000
Total external failure costs (D)	1,020,000	1,275,000	1,110,000	165,000
Total quality costs $\left(\text{A}+\text{B}+\text{C}+\text{D}\right)$	3,072,000	3,840,000	3,072,000	768,000

Table (2)

Year 2 budgeted figures are computed by dividing the costs of year 1 by sales of year 1 $12,000,000 and multiplying by sales of year 2, $15,000,000.

Increase in profit due to quality improvements is $768,000.

3.

To determine

Compute increase in profits in case quality costs are reduced to 3% of sales revenue.

Explanation of Solution

Computation of increase in profit:

Particulars	Amount ($)
Existing total quality costs (A)	3,072,000
Sales	15,000,000
Revised total quality costs (B) $\left(\$15,000,000\times 3\%\right)$	450,000
Increase in profit $\left(\text{A}-\text{B}\right)$	2,622,000

Table (3)